With taxes due in just a few hours, many Americans are scrambling to fill out 2009 returns. A lot has been made over the long-term tax impact of health care legislation, bailout packages, and a host of other government initiatives. Currently, marginal tax rates can approach (and sometimes exceed) 39% for many American corporations when state taxes are included. However, a recent study shows that American firms are able to take advantage of a variety of tax breaks and credits in order to get the effective rate down to roughly 28%, a far more manageable number. With tax season wrapping up, we take a look at how U.S. corporate tax rates compare to other developed and developing nations? And more importantly, do these numbers have a correlation to investment returns?
According to a recent report (PDF) compiled by PricewaterhouseCoopers in conjunction with the World Bank, some trends regarding corporate taxes among the G-8 and the BRIC countries begin to emerge. First, it is important to distinguish between statutory rates and effective tax rates. The report defines the effective rate as the the actual rate of corporate income tax paid as a percentage of profit before tax, while the statutory rate is the legally imposed rate before all deductions and credits are taken into account. This difference is crucial because some countries that have high statutory rates (such as France) do not end up having an effective rate that is nearly as high. Among the group of 11 nations (Russia is a member of both the BRIC and G-8 blocs), the United States has the fourth lowest tax effective tax rate, sandwiched between the United Kingdom and Germany.
According to the study, the countries with the lowest effective tax rates are Russia and France.
Effective Tax Rate: Approximately 17%.
Interesting Fact: In the post Soviet-Union world, many eastern European countries slashed their tax rates to bare bone levels. Russia was no different; the country currently has both the lowest effective and statutory tax rate of the 11 countries listed. Luckily for Russia it has been able to fund its budget with its massive oil and gas reserves, something that has allowed the country to keep these rock-bottom rates that have begun to attract foreign investment.
ETF Play: The most popular Russian ETF is the Market Vectors TR Russia ETF (RSX), which tracks the DAXglobal Russia+ Index. The fund is up more than 15% this year and it has more than doubled over the past 52 weeks.
Effective Tax Rate: Approximately 19%.
Interesting Fact: Shockingly, France has the second lowest effective corporate tax rate of the countries highlighted. The country did have one of the higher statutory tax rates, but the French system offers generous credits and deductions which allows the country to maintain its low effective rate.
ETF Play: A proxy of the French economy is the iShares MSCI France Index Fund (EWQ) which tracks firms in the MSCI France Index. This ETF is about even on the year, but it has produced a gain of close to 40% over the past 52 weeks.
Highest Effective Tax Rate Countries
The countries with the highest effective tax rates are Japan and Italy.
Effective Tax Rate: Approximately 43%.
Interesting Fact: The struggling Japanese economy charges the 2nd highest tax rate of the 11 countries surveyed. Like most of the top half of the list, firms in country end up paying a higher rate than the statutory rate suggests. However, in Japan’s case it is only a few percentage points of a difference.
ETF Play: The best representative for the Japanese economy in ETF form is the iShares MSCI Japan Index Fund (EWJ), which tracks the MSCI Japan Index. The fund is up close to 9% this year and about 25% in the past 52 weeks.
Effective Tax Rate: Approximately 52%.
Interesting Fact: What is most surprising about Italy’s effective rate is its comparison to the statutory rate, which comes in below that of the United States. However, after considering the impact of all the nuances of Italian tax rules, the effective tax rate surges to just over half of pre-tax profits.
ETF Play: The iShares MSCI Italy Index Fund (EWI) can be seen as a good proxy for the Italian economy by tracking the MSCI Italy Index. The fund has performed especially poorly this year, posting a loss of almost 5%. However, the ETF is up 35.9% over the past 52 weeks.
What Does It Mean?
So what does a low effective corporate tax rate mean for investors? Probably not much in the short-term, but over a longer period a trend begins to develop. Although RSX does not have data that goes back more than one year, the main Russian index has produced a return of roughly 30% a year over the past 5 years. Among the more developed countries over the same period, France has outperformed both Italy and Japan, posting an annualized gain of 3.15% compared to a gain of 0.72% for Japan and a loss of 3.3% for Italy.
It is interesting to note that among the two highest and lowest tax rate countries, a clear trend emerges; the lowest tax-rate countries have outperformed and the highest tax-rate countries over the last several years. The effective tax rates are obviously only one piece of the puzzle, but the relationship between tax rates and a positive business environment is easy to grasp conceptually. Just one more thing to keep in mind when shopping for an international ETF.
Disclosure: No positions at time of writing